Effective rural institutions: the missing link in market-based agricultural development? Why has market liberalisation often not resulted in increased rates of agricultural growth? A leading hypothesis sees failures in output and factor markets as the main cause, and institutional innovation as the remedy. If so, what kinds of institutional innovations are needed, and how can they be promoted?

Speakers: Jonathan Kydd, Imperial College and John Harriss, Director, DESTIN. London School of Economics.

The meeting was chaired by Steve Wiggins (ODI)

Meeting Report

This meeting was the first of a series of six arranged by the Future Agricultures Consortium, a group comprising researchers at the Institute of Development Studies, Sussex, Imperial College and ODI. The Consortium has been funded by DFID to stimulate debate and generate policy options for agricultural growth.

Jonathan Kydd (click here for presentation) started by defining institutions as the ‘rules of the game’, that is those underlying conventions and norms that make economic interchange more predictable. The common use of the term ‘institution’ to refer to an organisation is excluded, although every organisation has a set of rules of working practices that in themselves are institutional. He went on to outline some of the key concepts in institutional economics above all those of transactions costs. These are the costs of exchange: collection of information prior to the deal, negotiating with other parties to the exchange, and monitoring the subsequent exchanges.

Neo-classical economics assumes these costs away: markets are expected to operate with no friction at all. In reality, for some exchanges and in particular circumstances, transactions costs can be so high that exchanges do not take place, despite the clear economic opportunity for both parties to gain.

How do these ideas help us understand the issues in African agricultural development? In the 1970s and 1980s, many African countries, and especially those of Eastern & Southern Africa, created large parastatal enterprises, with monopoly powers, to manage the supply chain for agriculture. They typically provided inputs of seed and fertiliser to farmers, usually on credit, and then guaranteed to buy up whatever marketed surplus farmers would offer after the harvest. Transactions costs were low, but only since the state was prepared to subsidise operations and absorb losses. Although the agricultural parastatals had several successes in stimulating smallholder production of both food and cash crops, they proved unsustainable. Costs were high, inefficiencies were rife. Hence from the mid-1980s most of them were either closed or scaled down.

The new model for agricultural development was based on liberalised markets where the private sector was expected to provide inputs, supply credit and to buy up produce and to do so more efficiently than the old public sector monopolies. The public sector role has been reduced to that of providing ‘consensus public goods’ for example, roads, some agricultural research and extension. The institutional agenda has been one-dimensional, with much interest in property rights, but other institutions being more or less ignored.

The liberalised model has functioned where certain conditions apply: dense physical infrastructure, and a growing and diversified agriculture. Bangladesh would be a good example. But other cases, and in much of Africa where these conditions do not apply, the result has been the green revolutions that the parastatals had fostered have stalled. Faced by high transactions costs largely those of information by which suppliers and traders come to understand the economic potential and moral character of farmers, and by which farmers learn of the possibilities of inputs and markets private investors have been deterred and have turned their back on agricultural markets.

What are the implications of these observations? Jonathan Kydd and his colleagues argue that agricultural development should be seen as consisting of three stages of public action, thus:1. Establish the basic public goods that allow farmers to invest and produce roads, agricultural research and extension services, in areas with potential, irrigation schemes, and in some cases land tenure reform;2. Kick-start the markets by active state intervention in the provision of farm inputs, and, above all, seasonal finance for agriculture;3. Once a certain level of production has been reached, withdraw from the markets, leaving the field to the private sector.The case of India provides support for this model. Analysis of data carried out in collaboration with IFPRI shows varying returns to different investments through time. In the 1960s the highest returns to public investment were in roads and irrigation; and subsequently in the 1970s by spending on fertiliser subsidies and rural credit provision investments that are now anathema to those recommending liberalisation. By the 1990s the returns to inputs and finance had declined. Only in the later decades has education paid off in agricultural productivity.

The process of institutional development, following Fafchamps, is likely to see agricultural supply chains change from those in which face-to-face, intensive and personal exchanges between farmers and traders dominate; to those in which relations are defined as much by (organisational) hierarchies as by markets, and in which reputation is critical. Jumping stages too early and omitting stages one and two is likely to condemn a country to a low-level equilibrium trap. Otherwise profitable opportunities for agricultural development go begging since the transactions costs at early stages of development are just too high to allow sufficient returns to be made.

John Harriss (click here for presentation) sketched out the current dilemmas of agricultural development in India, starting by taking two examples of recent investments in farming. A private investor from the telecommunications sector, with funds from an merchant bank, tried to set up a schemes for export agriculture but found it difficult to ship produce promptly. Poor infrastructure and bureaucratic requirements at the border were blamed. On the public side, the World Bank has recently approved a loan to encourage diversified production in Uttar Pradesh, with a comprehensive package that includes innovations in the supply chain for more effective marketing.

Will such schemes benefit small and marginal farmers, or will they be biased towards larger farmers? When new lines of production for higher value markets have ‘credence characteristics’ for example, the way in which items have been produced, or pesticide applications and residues that cannot readily be checked by inspecting the produce, larger units have economies in providing such assurance. Farmer associations potentially allow smaller farms to interact with major players in supply chains, but the experience has been that they are typically captured by the larger farmers.

For staples production, in parts of India, the green revolution is running out of steam. Environmental problems of increasing pesticide resistance, and the depletion of aquifers have emerged. Prices have become more volatile in a liberalised setting. And input prices have risen more than those for output, squeezing margins. Moreover, liberalisation in the 1990s in India has meant that formal finance is less available for small farmers, pushing them towards informal lenders. The overall picture is gloomy, dramatically illustrated by media reports of suicides by farmers unable to pay off their debts.

Small and marginal farmers the majority of Indian farms are increasingly marginal by any definition are not out of the market: the problem they face is that they are deeply engaged in markets, but on adverse terms.

Do these changes indicate that only large-scale, capitalised farming can make progress? And if so, what is the fate of the small and marginal farmers? Or does India need a new round of agrarian reform, with the state returning to a more active role to ensure that the small and marginal farmers have access to finance, inputs and technical advice?

Discussion saw the following points being raised:What is the nature of the state and its policies that would be able to see through stages one and two of the model presented? In the case of India there were important contextual features to the start of the green revolution, including the legacy of long-term support to Indian agricultural research from Ford and Rockefeller, and large civil service with considerable capacity. Jonathan Kydd admitted that to some extent one must await a certain level of state capacity before renewed agricultural development would be possible. Regional trading blocks with harmonised agricultural policy would, however, allow conditions to be created for the smaller states where capacity is low.

Is there scope for collective action by smaller farmers? John Harriss noted that larger farmers can dominate and lock small and marginal farmers in to relations where they are condemned to poverty.

Was it possible to replicate the experience of Bangladesh where energetic promotion by micro-finance by NGOs had taken place? Both speakers noted that micro-finance tends to be provided for shorter term finance rather than farm input loans. The problem becomes acute where the farming system is based around a single, long season a year where loans are likely to be outstanding for six or more months. Many countries in Africa, for example, have only one cropping season. How feasible is it for states to withdraw from agricultural markets in stage three? Jonathan Kydd notes that in some cases the third stage sees an incomplete liberalisation: look, for example, at the European Common Agricultural Policy, or at the Republic of Korea, where the third stage has seen heavy state support to farmers. India is currently facing great difficulty in cutting back some forms of support to farmers.

How feasible is agricultural development, and smallholder agricultural development? Both speakers noted that progress was possible in unpromising circumstances. For example, between 1985 and 1993, Malawi had seen a genuine green revolution in the production of maize. In Bihar dairy co-operatives were had succeeded, despite the frequent failure of such associations in other sectors.

The chair summarised the meeting in three propositions:1. Institutions are clearly important to agricultural development;2. Institutions could be promoted by an active state or through private initiative deciding the more appropriate route in particular cases is a key question; and,3. Private initiatives tend to be understated in debates on institutions, and cases of success in private institutional innovations are under-reported and under-appreciated. A key challenge is to document more of such cases, and to understand the factors that make for success.

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About Future Agricultures

The Future Agricultures Consortium is an Africa-based alliance of research organisations seeking to provide timely, high-quality and independent information and advice to improve agricultural policy and practice in Africa.